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Ball back in ECB’s court - what options are left?

The European Central Bank (ECB) meeting tomorrow seems to have markets expecting additional quantitative easing measures to be unrolled. Eurozone data has been flat to weak over recent months and questions are being asked as to what further assets the ECB can include in its purchasing program to stimulate growth in the Euro bloc.

For the month of August, Eurozone inflation remained flat at 0.20%, far from the ECB’s 2% target. Business performance also disappointed with both manufacturing and services PMI’s coming in weaker at 51.7 and 52.8 index points respectively. On a positive note, the housing sector had a positive month in July and will be hoping to improve in August on the construction PMI data of 48.3.

Since the Brexit vote and consequent quantitative easing ensued by the Bank of England, the euro has come under significant upside pressure, rallying to a high point of 14% from the vote outcome, against what the ECB had in mind to support its asset purchasing program.

A weaker euro is attractive on international markets, as European goods gain favour over more expensive alternatives. Though with most major central banks, bar the US Federal Reserve, consistently enrolling monetary stimulus measures over the past year, long term guarantees of investor inflows are deficient.

Having already diverted away from classical monetary policy measures by including corporate bond issues as part of its asset purchasing program, it’s difficult to assess how the ECB can deliver to expectations come tomorrow’s meeting. An option is purchasing lower credit corporate debt issues, over and above the investment grade limitations imposed in the current purchases. However, such a move may come as a disadvantage for numerous reasons.

Including higher yielding corporate issues in a quantitative easing program may portray an image of desperation to investors by the ECB and negatively impact markets on beliefs the ECB have drawn their final cards in tackling Eurozone growth.

Another reason lower credit may not be the answer is due to the banking crisis. Following the Greece debacle and the non-performing loan saga affecting Italian banks, it would be risky for the ECB, at the forefront in imposing for Euro wide bank balance sheet reforms to purchase lower credit debt issues, given it’s the last line of Eurozone defense.

Given the above arguments, we could therefore expect an extension and an increase to the amount of current eligible securities for purchase, and how markets react will depend on whether investor expectations are met or not.

As per previous meetings, sovereign, investment grade and high yield bond spreads could all be expected to tighten come tomorrow, coupled with a depreciation in the Euro should the ECB deliver and meet investor expectations.

At this point it is tough determining a long term Eurozone forecast, but short term positioning into notably European debt and equities may be profitable over the coming weeks supported by an increase in market volatility should a material ECB impact be seen tomorrow. 

This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. 

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